Russian gas hinders Europe’s energy independence

Russian gas hinders Europe's energy independence

The emerging unique situation on the global gas market will obviously have various long-term consequences. And we can look forward to a number of developments which will also change the approaches and strategies of the gas companies, be they importers or exporters of gas and LNG.

One of the interesting aspects is that a considerable share of Russian gas destined for Europe appears to be Schrödinger’s gas: it appears to be available (as a potential supply possibility), but at the same time it is not available (as physically supplied gas). Let us explain why this is important for the future of the entire global market.

When gas consumers conclude long-term supply contracts and gas producers correspondingly decide to invest into new gas extraction or liquefaction capacities, they roughly keep in mind the balance of supply and demand in the market. Let’s say a four or five percent annual growth in LNG demand is compared with the supply already being prepared for production. Of course, there are always a lot of uncertainties: demand will be higher or lower, construction will be faster or slower, something will break down in the existing facilities. But you still have to guess and somehow plan from that – it’s better than nothing. Now the producers cannot understand: how to evaluate the overhang of Russian gas, which is there, but not used.

On the one hand, prices are too high, in no small part because of the decline in Russian supplies. On the other hand, if for one reason or another Russian gas exports increase to baseline levels, it will bring down prices. For a long time, it was thought that the approximate volume of Russian gas supply was easily predictable, helped by the well-known volume of existing long-term contracts, the interest in which has always been mutual. Now, however, exports are below contracted volumes and Gazprom has already notified European importers of force majeure (linked to known problems with gas turbines) so as not to pay penalties for under-delivery. Although, European counterparties will probably file a lawsuit and the story will have a long continuation – in which case we will know the whole gas turbine operation in detail.

In any case, the head of Uniper, although quite streamlined – probably to have room for manoeuvre – has already spoken about the current difficulties of working on the long-term contract with Gazprom, hinting that it could be revised.

In other words, in the current situation, the very institution of the long-term contract is at risk. And this, by and large, follows from the whole logic of events. The EU does not hide the fact that it does not apply sanctions to the purchase of Russian gas, nor does it refuse to buy it just because it cannot be replaced quickly. But if a replacement is found in the future, it means that any contract could be torn up by the EU. And that means that Gazprom will no longer have to hang on to its contracts. There will always be demand for gas in a scarce market, and in the case of a surplus market, Europe could simply refuse Russian supplies, ignoring past agreements.

Moreover, if such restrictions are not made in the future, other LNG imports will have difficulty competing with Russian supplies in the event of a price war, and the EU will again be unable to reduce its dependence on Russian gas. So, as the EU needs less Russian gas than Gazprom is willing and able to offer (we are not discussing whether this will happen in a year, two years or five – there are many uncertainties), we can expect rationing of Russian gas imports by the EU.

At the same time, the current crisis is also disrupting long-term agreements on LNG supplies – it is true that Asian consumers are suffering. It has already been repeatedly discussed that sellers of LNG under “cheap” oil-linked contracts refuse to supply, paying ridiculous compensation.

Usually such cases have involved small, short-term contracts, so attitudes towards breaking such arrangements are more relaxed. However, the latest example is indicative as it is a twenty-year contract.

It was used by Gazprom Germania’s subsidiary to supply LNG to India under an oil-linked contract. After Gazprom Germania came under the interim management of the German regulator (and has nothing to do with Gazprom after the well-known events – on the contrary, the company was put on the list of unfriendly and is under blocking Russian sanctions), the company simply refused to meet its obligations to India’s Gail. The “physics” of the contract was always known: the gas that the then Gazprom trader bought from Yamal LNG was supplied to India. Yes, in fact it was not always profitable to send Yamal gas to India, sometimes it would be easier to sell it in Europe and for India to buy somewhere closer. But in terms of the total balance, including money, it is the Yamal LNG that was and is being purchased with an oil tie-up as well. In other words, there is no loss for the trader – simply, having refused deliveries to India, the company decided to use scarce LNG for its own needs. The reader may ask: can Yamal LNG now sell to a company on the Russian sanctions list? Yes, there is an exemption until the end of August, and Yamal LNG has so far fulfilled all its obligations.

Examples of tensions beyond monetary relations could go on and on. There is Australia, which wants to limit LNG exports (strictly speaking, this is an old domestic gas shortage problem in the country). And uncertainties related to China’s purchase of LNG from the US – China has many plans and the risks are obviously growing.

All this will lead to new forms of interaction on the gas market and revision of strategies. For example, we can assume that buyers will be more willing to reach out to producers, bypassing intermediary traders, or get some new forms of guarantees. Otherwise, indeed, what is the point of a long-term contract if it can be terminated with clearly insufficient compensation.

As for the gas and LNG exporters themselves, so far so good for them. If Europe legally refuses to buy some of the Russian gas, the market deficit will remain for a long time. Otherwise, the main risk for the new LNG producers is the one we started the conversation with. A huge gas overhang, which Gazprom could, given a certain development, sell in Europe at virtually any price. This is partly why decisions have only been made on two LNG plants in the US since the beginning of the ETR. It is no exaggeration to say that a future EU decision is one of the defining ones for the global gas market in the coming years.

In case Russian exports remain unrestricted for all gas producers, a “gas OPEC” becomes relevant, where Gazprom will have the key role due to circumstances. The idea of such an organization has been theoretically discussed for more than a decade, and the GECF (Forum of Gas Exporting Countries) is often considered as a possible framework. It is a beautiful idea, but the well-known differences between the gas market and the oil market have so far prevented its realisation.

Nevertheless, Gazprom in the European market (and in the global market, given the link via LNG) has resembled Saudi Arabia in the oil segment. The company had spare capacity that could be balanced by influencing the price. Moreover, for years Gazprom tried to keep European quotes below the full cost of US LNG – so that such supplies to Europe would be unprofitable. Now a similar story could become relevant again. But let’s wait for the critical period to pass and for some European decisions – so far Europe wants to buy even much more gas than Gazprom offers.

Alexander Sobko, RIA

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